In deciding between a conventional mortgage and an FHA-insured mortgage, the general rule is that if you qualify for the conventional mortgage, you take it; only if you don’t qualify for the conventional do you accept the FHA.

The rationale for the rule is that on FHAs, borrowers pay an upfront mortgage insurance premium of 2.25 percent of the loan amount, which is added to the loan balance, and an annual premium of 0.055 percent of the balance paid monthly.

On conventional loans, in contrast, borrowers pay mortgage insurance only if the ratio of loan amount to property value (LTV) exceeds 80 percent, and the premiums are lower than those on FHAs.

Recently, I decided to check this rule. Is it always the case that, if the borrower qualifies for both, the conventional will be the better deal? I defined a "better deal" as one that will cost less over the period the borrower expects to be in the house. I used calculator 9ci on my website to compare the total costs.

I also wanted to see exactly how much more difficult it is to qualify for a conventional than for an FHA. My focus here is on differences in the minimum allowable credit score and the maximum allowable LTV on the two types of mortgages.

I used the prices and qualification requirements posted by 20 lenders with Home-Account.com as of April 29. While mortgage prices change from day to day, underwriting requirements — and the relationship between underwriting requirements and price — change quite infrequently.

Pricing and underwriting categories: I quickly realized that the home loan market today is now divided into five pricing and underwriting categories.

  • "Conforming standard loans" are for amounts up to $417,000 and eligible for purchase by Fannie Mae and Freddie Mac.
  • "Conforming jumbo loans" are for amounts up to $729,750, the maximums varying by county, and eligible for purchase by Fannie Mae and Freddie Mac.
  • "Nonconforming jumbo loans" are for amounts that exceed the conforming jumbo county limits, which range up to $729,750.
  • "FHA standard loans" are for amounts up to $217,050 and eligible for insurance by FHA.
  • "FHA jumbo loans" are for amounts up to $729,750, the maximums varying by county, and eligible for insurance by FHA.

Since FHA jumbos are priced higher than FHA standard, in the market segments where borrowers qualify for both conforming standard and FHA jumbos, the cost of the conforming is lower.

Indeed, in most segments, the FHA rate is higher and combined with the mortgage insurance premium, the total cost difference is quite large. The $400,000 borrower who can’t qualify for a conforming standard loan pays a larger penalty going with FHA than the $200,000 borrower.

The $600,000 loan: The maximum LTV on a conforming jumbo is 90 percent rather than 95 percent. Borrowers who can qualify only for FHAs either have credit scores below 680 and need LTVs higher than 80 percent, or they need an LTV above 90 percent at any credit score.

In cases where the borrower qualifies for the conventional as well as the FHA, the same niche emerged with a relatively low FHA rate as with the $200,000 loan: a 640 credit score and an 80 percent LTV. Over periods shorter than 11 years, the conventional cost was lower, and beyond 11 years, the FHA cost was lower. In all other niches, the conventional cost was lower.

In sum, the generalization that a borrower who qualifies for a conventional should take it rather than an FHA holds up pretty well. I found one exception in both the less-than-$217,500 and the $417,001-$729,750 loan size groups, but it applies only to borrowers who expect to have their mortgage a long time.

The disadvantage of not qualifying for a conventional loan is most costly to borrowers in the intermediate loan size group, $217,500-$417,000.

Thanks to Jack Pritchard for helpful comments.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

***

What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

Show Comments Hide Comments
Sign up for Inman’s Morning Headlines
What you need to know to start your day with all the latest industry developments
By submitting your email address, you agree to receive marketing emails from Inman.
Success!
Thank you for subscribing to Morning Headlines.
Back to top
Only 3 days left to register for Inman Connect Las Vegas before prices go up! Don't miss the premier event for real estate pros.Register Now ×
Limited Time Offer: Get 1 year of Inman Select for $199SUBSCRIBE×
Log in
If you created your account with Google or Facebook
Don't have an account?
Forgot your password?
No Problem

Simply enter the email address you used to create your account and click "Reset Password". You will receive additional instructions via email.

Forgot your username? If so please contact customer support at (510) 658-9252

Password Reset Confirmation

Password Reset Instructions have been sent to

Subscribe to The Weekender
Get the week's leading headlines delivered straight to your inbox.
Top headlines from around the real estate industry. Breaking news as it happens.
15 stories covering tech, special reports, video and opinion.
Unique features from hacker profiles to portal watch and video interviews.
Unique features from hacker profiles to portal watch and video interviews.
It looks like you’re already a Select Member!
To subscribe to exclusive newsletters, visit your email preferences in the account settings.
Up-to-the-minute news and interviews in your inbox, ticket discounts for Inman events and more
1-Step CheckoutPay with a credit card
By continuing, you agree to Inman’s Terms of Use and Privacy Policy.

You will be charged . Your subscription will automatically renew for on . For more details on our payment terms and how to cancel, click here.

Interested in a group subscription?
Finish setting up your subscription
×